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Get Four
|  | NOVEMBER 9, 2004
 FOCUS STOCK By Marie Driscoll, CFA Pacific Sun's Golden Glow The chain's savvy emphasis on hip styles for the Generation Y crowd continues to pay off, earning it S&P's highest rating There's strength in numbers. And we at Standard & Poor's Equity Research Services believe that old adage is particularly apt in the case of youth-oriented retailer Pacific Sunwear (PSUN; recent price, $24). We think its multiplicity of apparel, accessories, and footwear brands is a key competitive advantage, allowing management to tweak brand assortments to best meet the changing tastes of its core customers in a highly competitive Generation Y marketplace. We believe the company's expansion plans will support what we view as industry-leading sales and earnings growth momentum. Given our view of the youthful store base, favorable demographics, and expansion opportunities, we anticipate continued sales and earnings momentum. Consolidated same-store sales gains have averaged 8.9% over the past eight years. Based on our projection of above-average three-year annual EPS growth of 24% to 26%, we regard the shares as undervalued. The stock carries Standard & Poor's highest investment recommendation of 5 STARS, or buy. YOUTHFUL FOLLOWING. PacSun is a leading specialty retailer of casual apparel, accessories, and footwear catering to teens and young adults, a subgroup of the Gen Y demographic (those born between 1979-1997) with a population of approximately 32 million and $170 billion in spending power. As of Oct. 30, it was operating 977 stores, primarily in regional shopping malls in 50 states and Puerto Rico. There are 734 Pacific Sunwear stores, 84 Pacific Sunwear outlet stores, and 159 d.e.m.o. stores. This store base is fairly young, considering 41% have been opened in the past three years. The stores are concentrated in the Northeast, Midwest, Southeast, and California. In fiscal 2005 (ending January), the outfit plans to add about 110 new stores, including 67 PacSun stores, 5 PacSun outlet stores, and 41 d.e.m.o. stores, and plans to expand or relocate about 35 stores to larger locations, for about 15% square footage growth (from 2,997,000 square feet at the end of fiscal 2004). MALL FOOTPRINTS. Pacific Sunwear stores, the company's original and primary store format, average about 3,500 square feet and specialize in board-inspired casual apparel, footwear, and related accessories. The broad wardrobe selection of popular and emerging brands, offered together with its PacSun brand and supplemented by private brands, seeks to differentiate PacSun from its competitors. The stores are located primarily in enclosed regional shopping malls. In mid-2003, the company announced plans to open PacSun stores at nonmall locations, such as power strips and lifestyle centers. Including 100 outlet stores, the company targets a store count of 1,000 PacSun stores through fiscal 2008. PacSun outlet stores average about 4,100 square feet, and are located in open-air and enclosed value-oriented outlet malls. Merchandise at PacSun Outlets consists primarily of off-price branded merchandise, private-brand merchandise, and a smaller selection of full-priced branded merchandise. The d.e.m.o. concept, introduced in fiscal 1998, offers a broad assortment of hip-hop music inspired casual apparel and accessories that target males and females aged 16 to 24. There's no merchandise overlap with PacSun stores and thus little if any cannibalization, in our opinion. The d.e.m.o. stores are located in regional malls and average 2,400 square feet, although PacSun is seeking larger locations of approximately 2,500 square feet to 3,000 square feet. It intends to expand the d.e.m.o. concept to 400 stores by fiscal 2008. "UNIQUE MERCHANDISE." Pacific Sunwear supplements its nationally branded merchandise with private brands, which we believe contributes to its status as a key fashion resource for casual lifestyle apparel while providing differentiation from its competitors. Private-label goods are internally developed and provide the company with greater inventory control, the ability to capitalize on emerging fashion trends and are considerably more profitable than their national branded peers. In fiscal 2004, 38% of PacSun's sales came from young men's ("guys'," in the company's parlance) apparel, 31% from girls' apparel, 19% from accessories, and 12% from footwear. In fiscal 2004, no single vendor accounted for over 8% of total sales. Private-label merchandise accounted for 32% of net sales. In our view, the company's multibrand approach stands in contrast to typical vertical-apparel retailers such as American Eagle (AEOS; S&P STARS rank, 3 STARS, hold; recent price, $42), Abercrombie & Fitch (ANF; 4 STARS, accumulate; $43), or Aeropostale (ARO; 4 STARS; $31) where one brand and a single point of view is provided. This strategy works well when a retail brand is in favor, and suffers, in our view, when the tide turns. We believe that recent fashion trends favor differentiated and unique merchandise, whereby individuals can assemble their own look, such as Urban Outfitters (URBN; 3 STARS; $44), and the contemporary collections that are restoring vigor to better department stores. TARGETING WOMEN. While the company's core Pacific Sunwear chain may be approaching market saturation, we see incremental opportunities on numerous fronts. The company has various initiatives in place to increase the percentage of total apparel sales to females from the 47% projected for fiscal 2005 to a more typical 60% (the norm for dual-gender specialty-apparel retailers). As this occurs, margins should expand, as merchandise margins for women's apparel are approximately 400 to 500 basis points wider than for their male counterpart. Girls' apparel and accessories remain near-term growth drivers, in our view, but we see attractive opportunities in the guys' business as well, following the exit of two competitors, Mr. Rags and Gadzooks. Additional opportunities in footwear (about 16% of fiscal 2005 projected business) and accessories (20%) exist as well, in our opinion. We regard the d.e.m.o. chain as the company's growth vehicle. PacSun plans to more than double the d.e.m.o. store base to a projected 400 stores from the 159 currently, a goal we think could be lifted to as many as 500 stores. The d.e.m.o. chain participates in the lucrative music and celebrity inspired hip-hop urban apparel, accessories, and footwear arena, an estimated $10 billion retail market.
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